Overviewof accounting reportingandtaxation

Overview of Accounting, Reporting and Overview of Accounting, Reporting and Taxation of Taxation of

Futures, Options and other Futures, Options and other DerivativesDerivatives

By: Sanjay AgarwalFounder of “Voice of CA”, NGOEmail: [email protected]

Accounting aspects

Accounting Aspects

Issues ‐

AO

can

not

disregard

accounting

standards

of ICAI

Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable.AO cannot disregard the method of accounting followed by the assessee where the method of accounting is based on a standard or guideline commended for adoption by a professional body such as the ICAI.

Woodward Governor India (P.) Ltd. vs CIT [2009] 179 TAXMAN 326 (SC)CIT vs Virtual Soft Systems Ltd. [2012] 18 taxmann.com 119 (Delhi)Jt CIT vs K. Raheja (P.) Ltd. [2006] 102 ITD 414 (Mum.‐ Trib.)

Notified Accounting Standards by central government (Till date) under section 145 of income tax

act, 1961

A.

Accounting

Standard

I ‐

relating

to

disclosure

of accounting policies.

B.

Accounting

Standard

II ‐

relating

to

disclosure

of prior period and extraordinary items and changes in accounting policies

Draft Tax Accounting Standards

Drafts of the Tax Accounting Standards on the following issues based on the corresponding Accounting Standard issued by the ICAI after harmonising the same with the provisions of the Act

S.

No.TAS Corresponding

AS

1. Disclosure of Accounting Policies AS‐12. Valuation of Inventories AS‐23. Events Occurring After the Previous

Year AS‐4

4. Prior Period Expense AS‐55. Construction Contracts AS‐76. Revenue Recognition AS‐97. Accounting for Tangible Fixed Assets AS‐10

Draft Tax Accounting Standards

S. No. TAS Corresponding

AS

8. The Effects of Changes in Foreign Exchange Rates

AS‐11

10. Securities AS‐1311. Borrowing Costs AS‐1612. Leases AS‐1913. Intangible Assets AS‐2614. Provisions, Contingent Liabilities

and Contingent AssetsAS‐29

Contd…

Accounting standards V. Tax Accounting Standards ‐

In respect of Derivatives

Accounting standards by ICAI TAS ‐

1

The mark‐to‐market gain/ loss or an expected gain/ loss should be recognized in the statement of Profit and Loss as per AS– 30, para 99(a) (Derivative Hedging instrument at fair value).

As

per

TAS

on

Accounting

Policies

The mark‐to‐market loss or an expected loss (except those covered by other TAS) shall not be recognized.

Accounting Standards issued by ICAI ‐In respect of Financial Instruments including derivatives

Contd…

AS‐30 issued by ICAIThe objective of this Standard is to establish principles for recognising and measuring financial assets, financial liabilities and some contracts to buy or sell non‐financial items.Requirements for presenting information about financial instruments are in Accounting Standard (AS) 31, Financial Instruments: Presentation. Requirements for disclosing information about financial instruments are in Accounting Standard (AS) 32

Contd….

AS – 31‐

Presentation of financial instruments

Objective:To

establish

principles

for

presenting

financial

instruments

as

Liabilities

or

Equity,

and

for

off‐setting financial assets and financial liabilities.

Scope:1.

Classification

of

Financial

instruments,

from

the

perspective

of

the

issuer,

into

financial

assets,

financial liabilities and equity instruments.

2.

Classification

of

related

interest,

dividends,

losses

and gains.

3.

Circumstances

in

which

financial

assets

and

financial liabilities should be offset.

AS – 32‐

Disclosure of financial instruments

The objective of this Standard is to establish principles for presenting financial instruments as liabilities or equity and for offsetting financial assets and financial liabilities. It applies to the classification of financial instruments, from the perspective of the issuer, into financial assets, financial liabilities and equity instruments; the classification of related interest, dividends, losses and gains; and the circumstances in which financial assets and financial liabilities should be offset.

Reporting aspectsReporting aspects

Determination of turnover in non‐

delivery based transactions

The ICAI has issued guidance notes for accounting treatment with a view to determine the turnover for the purpose of sec 44AB.

The total of positive and negative, or favorable and unfavorable differences shall be taken as turnover.

Guidance on accounting treatment

Premium received on sale of options is to be included in turnover.

In respect of any reverse trades entered, the difference thereon shall also form part of the turnover.

Tax Audit

In case a lot of transactions are executed in routine, then it can be held as an adventure in the nature of trade and profit or loss from such a business will be covered under the head PGBP.

In case of derivatives of securities the profit/ loss is not treated as speculative. Moreover, it is said to be non‐ speculative.

Tax Audit

However, in case of commodity transactions, it shall be considered as speculative, if the same is not for the purpose of hedging (upto AY 2013‐ 14).

As per sec clause (e) of 43(5) of the Income Tax Act, 1961, commodity transactions shall be considered as non‐speculative, from AY 2014‐ 15 as per the amended Finance Bill 2013 (Passed by Lok Sabha).

Contd…

Computation of turnover

Eg.

a) Mr. X offered to purchase 5000 shares at a cost

of Rs. 1000 each and also offered to sell 5000 shares at a price of Rs. 1100 each of Reliance Ltd.

(b)

He also offered to purchase 1000 shares at a cost of Rs. 3000 each and also offered to sell 1000 shares at a price of Rs. 2800 each of L&T.

Thus, the turnover

of Mr. X will be calculated as under:(i)Turnover

in

(a)

above,

Rs.

55Lacs‐

50

Lacs

=

Rs.

5

Lacs(ii)Turnover

in

(b)

above,

Rs.

28

Lacs‐

30

Lacs

=

Rs.

(2

Lacs)

Thus, the net turnover

of Mr

X. would be (i) + (ii) = Rs. 7 Lacs.

Taxation aspects

MAJOR ISSUES……

Whether the derivative transaction is a speculative transaction?

Taxability‐ whether as business income or capital gains?

Whether set off of losses from derivative transactions is possible?

Taxation aspects

Key Points

No specific provision under the Act regarding taxability of derivatives.

Provisions having an indirect bearing on derivative transactions are Section 28, sec. 73(1) and sec.43(5).

The presentation and disclosure of derivatives in financial statements is required by ‘AS‐31 and 32’respectively issued by ICAI.

Speculation transaction as per Sec 43(5) of IT Act

Speculative transaction means a transaction in which a contract for the purchase or saleof any commodity including stock and shares,is periodically or ultimately settledotherwise than by actual delivery or transfer of commodity or scrips.

Contd…

Provisions to Sec 43(5)

Transactions not to be deemed as speculative :

(a)

a

contract

in

respect

of

raw

materials

or merchandise

entered

into

by

a

person

in

the

course

of

his

manufacturing

or

merchanting business

to

guard

against

loss

through

future

price fluctuations in respect of his contracts for actual

delivery

of

goods

manufactured

by

him

or merchandise sold by him, or

Contd…

(b)

a

contract

in

respect

of

stocks

and

shares

entered into

by

a

dealer

or

investor

therein

to

guard

against

loss

in

his

holdings

of

stocks

and

shares through price fluctuations, or

(c)

a

contract

entered

into

by

a

member

of

a

forward market

or

a

stock

exchange

in

the

course

of

any

transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member, or

Contd…


(d)

an

eligible

transaction

in

respect

of

trading

in derivatives

referred

to

in

clause

(ac)

of

section

2

of

the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognized stock exchange.

Eligible transactions on BSE and NSE w.e.f. 25th

Feb 2006 shall

not

be

considered

as

speculative

vide

Notification

No.

2/2006,

dated

25‐1‐2006

of

Income Tax Act, 1961.

Contd…


DerivativesAs per clause (ac), of sec 2 of Securities Contract (Regulations) Act, 1956, Derivatives include :‐(a) a security derived from a debt instrument, share,

loan, whether

secured

or

unsecured,

risk

instrument

or

contract

for

differences

or

any

other form of security.

(b)

a

contract

which

derives

its

value

from

the prices, or index of prices, of underlying securities.

The definition of derivatives earlier rederred to in clause (aa) was re‐lettered as clause (ac), of sec 2 of Securities Contracts (Regulations) Act, 1956 vide Circular no. 14/2006, Dated 28‐12‐2006 of the Income Tax Act, 1961.Accordingly, the amendment has been done in clause (5) of section 43 of the Income Tax Act, 1961.

Explanation ‐

Eligible transaction

A)

carried

out

electronically

on

screen‐based

systems through

a

stock

broker

or

sub‐broker

or

such

other

intermediary registered u/s

12

of the SEBI Act, 1992 (15 of

1992)

in

accordance

with

the

provisions

of

the

SC(R)A,

1956

(42

of

1956)

or

the

SEBI

Act,

1992

(15

of 1992)

or

the

Depositories

Act,

1996

(22

of

1996)

and

the

rules,

regulations

or

bye‐laws

made

or

directions issued

under

those

Acts

or

by

banks

or

mutual

funds

on a recognized stock exchange; and

Explanation ‐

Eligible transaction

(B) which

is

supported

by

a

time

stamped

contract note

issued

by

such

stock

broker

or

sub‐broker

or

such other intermediary to every client indicating in the

contract

note

the

unique

client

identity

number

allotted

under

any

Act

referred

to

in

sub‐clause

(A) and

permanent

account

number

allotted

under

this

Act;

Explanation‐

Recognized Stock Exchange

A recognized stock exchange as referred to in clause (f) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose.

BSE and NSE as recognized stock exchanges.

Amendments as in Finance Bill, 2013

As passed by Lok

Sabha‐

Insertion of clause (5) in the proviso, w.e.f. 1stday of April 2014.

Clause(e)‐ “An eligible transaction in respect of trading in commodity derivatives carried out in a recognized association”


Explanation shall be renumbered as “Explanation 1” thereof and in the Explanation 1 as so renumbered, for the words “this clause” the word, brackets and letter “clause (d)” shall be substituted.


Explanation 2 for the purposes of clause (e), the expressions –

Commodity derivatives: shall have the meaning as assigned to it in Chapter VII, of the Finance Act, 2013 (i.e. Commodities Transaction Tax).

Contd…

Explanation 2

“Eligible transaction”: Means any transaction‐(A) carried out electronically on screen‐based systems through member or an intermediary, registered under the bye‐laws, rules and regulations of the recognized association for trading in commodity derivatives in accordance with the provisions of the Forward Contracts (Regulation) Act, 1952 and the rules, regulations or bye‐laws made or directions issued under that Act on a recognized association; and

Contd…



Explanation 2(B)

which

is

supported

by

a

time

stamped

contract

notes

issued

by

such

member

of intermediary

to

every

client

indicating

in

the

contract note, the unique client identity number allotted under the Act, rules, regulations or bye‐ laws referred to

in

sub‐clause

(A),

unique

trade

number and

permanent

account

number

allotted under this Act;

Contd…


Explanation 2“Recognized association” means a recognized association as referred to in clause (j) of section 2 of the Forward Contracts (Regulation) Act, 1952 and which fulfils such conditions as may be prescribed and is notified by the Central Government for this purpose.’

Contd…

Capital Gain vs. Business income

As per section 2(14) of the Act, ‘capital asset’means property of any kind held by an assessee, whether or not connected with his business or profession.

Derivatives are security defined under SC( R) Act or the contracts carrying right, thus they can be considered as a property carrying value.

Tax treatment in brief

Non‐corporate assesseeInvestor‐taxability

under

capital gains

Businessman‐i)

if

actual

delivery,

under

PGBPii)

if

no

actual

deliver,

speculation(sec. 43)

Corporate assesseeInvestor‐

taxability

under

capital gains

Businessman‐i)

If actual delivery:*

If

banking

co.

regarding

shares‐

NormalPGBP

(expl.

To sec. 73)* Any

co.

regarding

any

other

commodity‐NormalPGBPOther

Co.

regarding

shares‐

Speculation (expl.sec. 73)ii)

If no actual delivery‐

speculation

(sec. 43)

Set off of speculation losses‐Sec 73 of IT Act, 1961

1)

Any

loss,

computed

in

respect

of

a

speculation business carried on by the assessee, shall not be set off except

against

profits

and

gains,

if

any,

of

another

speculation business.

2)

Where

for

any

assessment

year

any

loss

computed

in respect

of

a

speculation

business

has

not

been

wholly

set

off

under

sub‐section

(1),

so

much

of

the

loss

as

is not so set off or the whole loss where the assessee

had

no

income

from

any

other

speculation

business,

shall, subject

to

the

other

provisions

of

this

Chapter,

be

carried

forward

to

the

following

assessment

year, and—

(i) it

shall

be

set

off

against

the

profits

and gains, if any, of any speculation business carried on

by

him

assessable

for

that

assessment

year;

and

(ii) if

the

loss

cannot

be

wholly

so

set

off,

the amount

of

loss

not

so

set

off

shall

be

carried

forward to the following assessment year and so on.

Contd…


(3)

In

respect

of

allowance

on

account

of

depreciation or

capital

expenditure

on

scientific

research,

the

provisions

of

sub‐section

(2)

of

section

72

shall

apply in

relation

to

speculation

business

as

they

apply

in

relation to any other business.

(4)

No

loss

shall

be

carried

forward

under

this

section for

more

than

four

assessment

years

immediately

succeeding the assessment year for which the loss was first

computed

(vide

Circular

no.

3/2006

dated

27.02.2006 w.e.f. AY 2006‐07).

Contd…


Explanation.—Where any part of the business of a company [other than a company whose gross total income consists mainly of income which is chargeable under the heads "Interest on securities", "Income from house property", "Capital gains" and "Income from other sources"], or a company the principal business of which is the business of banking or the granting of loans and advances) consists in the purchase and sale of shares of other companies, such company shall, for the purposes of this section, be deemed to be carrying on a speculation business to the extent to which the business consists of the purchase and sale of such shares.

Contd…


Clarification for carry forward of speculative losses

The loss in respect of speculation business shall be allowed to carried forward for four years in place of eight years vide Circular no. 3/2006, dated 27.02.2006.

Finance Act, 2005 has amended the said sub‐section (4) so as to reduce the period of loss to be carried forward from eight assessment years to four assessment years.

Applicability: From A.Y. 2006‐07 onwards.

Issues……

Whether

transaction

in

an

exchange

before

the

release of notification would amount to speculation?

No,

the

notification

is

only

clarificatory

in

nature, therefore,

the

transaction

would

not

be

considered

as

speculative.

ACIT,

Vs.

Arnav

Akshay

Mehta

[2012]

25

taxmann.com 252 (ITAT ‐

Mum.)

ACIT, Vs. Vimal

Vadilal

Shah [2012] 27 taxmann.com

197 (ITAT – Ahm.)

Issues……

Whether mere violation w.r.t. to fulfillment of conditions of invoice and contract would amount to speculation?

Mere intention of law was that the transactions to be carried out through recognized stock exchange and hence, not to be considered as speculative.

Vibha Goel Vs. JCIT, [2012] 25 taxmann.com 142 (ITAT – Chandigarh)

Issues

If actual delivery of share scrips does not take place both for purchases as well as sales – Sec 43(5) –delivery recalled by brothers – No actual delivery.

Speculative transation – Loss cannot be set off against business income.

ACIT Vs. Claytone Commercial Co. Ltd. (ITAT, Delhi) 67 ITD 118

Ram Lal & Sons Vs. ITO (ITAT, Asr) 71 ITD 256

Other Issues…….

Whether derivatives transactions not settled through delivery of the asset would be considered as speculative?

Derivatives transactions (not a commodity derivative) through a recognized stock exchanged shall not be speculative.

[Dy. CIT v. Paterson Securities (P.) Ltd. [2010] 127 ITD 386 (Chennai)]

Speculative business income

Explanation 2 of Sec 28 of Income Tax Act, 1961‐

Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as "speculation business") shall be deemed to be distinct and separate from any other business.

Tax treatment for derivative transactions

Recapitulation

Speculative transactions……..

Intra‐day trading shall be considered as speculation business transactions and the income there from would be either speculation gains or losses.

However, if based the on facts and circumstances of your case, you can prove that though delivery was not actually taken it was within your normal business transaction, it could be treated as non‐speculation business income.

Taxability of speculative transactions

Income from speculation gains is taxed at the normal rates.

Speculation losses can be set off only against speculation gains as per sec 73.

Trading in derivatives (futures and options) is treated as non‐speculation business even though delivery is not effected in such transactions.


Speculation losses can be carried forward for a maximum of four years immediately succeeding the relevant assessment year vide Circular no. 3/2006, dated 27.02.2006 of Income Tax Act, 1961.

Considering the fact, the physical existence of money, currency can be considered as a commodity.

Contd…


Therefore, currency derivatives transactions shall be covered by main part of the speculative transactions definition.

However, there have been different decisions of various Tribunals of considering currency derivatives transactions as commodity and non‐commodity transactions.

Contd…


Also, currency derivatives are transacted at stock exchanges and not on commodity exchanges.

Therefore, should not be considered as speculative transactions, if they qualify as derivatives under SCRA, 1956.

Contd…


Currency transactions on stock exchanges, indicates them to be a type of securities.

Therefore, qualify for treatment as security derivatives (non‐speculative).

Contd…

Speculative transactions

Since, the income from speculative transactions is considered as business income,

Audit would be required if the turnover exceeds 60 Lacs (1 Cr w.e.f. FY 12‐13).

Sale value of the transaction shall be considered for the purpose of calculation of turnover.

Contd…

Provisions of Sec 44AD to have impact

In respect of loss from non‐delivery of transactions such as F&O and derivatives.

It mandates disclosure of at least 8% of net profit on gross turnover and if not, books of accounts are required to be maintained.

There is no clear cut guidelines, as to whether assessee w.r.t. to derivatives transaction, can use the provision of this section or not.

For any queries, feel free to contact:

CA Sanjay AgarwalFounder of “Voice of CA”Email id : [email protected]

Assisted by : Pallav Agarwal

mailto:[email protected]

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